Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Pfleiderer Group Spólka Akcyjna (WSE:PFL) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. I will be using the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in December 2018 so be sure check out the updated calculation by following the link below.
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow estimate
|Levered FCF (€, Millions)||€52.77||€55.75||€60.37||€70.62||€81.92|
|Source||Analyst x3||Analyst x3||Analyst x2||Analyst x1||Est @ 16%, capped from 28.19%|
|Present Value Discounted @ 14.03%||€46.28||€42.88||€40.72||€41.78||€42.50|
Present Value of 5-year Cash Flow (PVCF)= €214m
The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 3.3%. We discount this to today’s value at a cost of equity of 14%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = €82m × (1 + 3.3%) ÷ (14% – 3.3%) = €791m
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = €791m ÷ ( 1 + 14%)5 = €410m
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is €625m. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of PLN51.6. Relative to the current share price of PLN30.95, the stock is quite good value at a 40% discount to what it is available for right now.
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Pfleiderer Group Spólka Akcyjna as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 14%, which is based on a levered beta of 1.603. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For PFL, there are three pertinent factors you should further examine:
- Financial Health: Does PFL have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does PFL’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of PFL? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. The Simply Wall St app conducts a discounted cash flow for every stock on the WSE every 6 hours. If you want to find the calculation for other stocks just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.